Income protection tax change likely to affect your salary, benefits

Life assurance companies have responded differently to the
change in how income protection policies are taxed, which took effect at the
beginning of this month, and you should know how this could affect your
finances.

Income protection policies provide you with a monthly income
if you become disabled.

How your life assurer deals with the change could:

Affect your take-home pay at the end of March;

Boost your income protection benefits if you
claim;

Result in an immediate reduction in your
premiums and benefits;

Result in you eventually paying more for cover;
or

None of the above.

The Taxation Laws Amendment Act of 2014 provides that, from March
1, income protection policy premiums will no longer be tax-deductible, while
the benefits paid by these policies will be tax-free.

The change harmonises the tax treatment of policies that
cover you for disability, death or severe illness, regardless of whether the
benefit is paid as a lump sum or a monthly income. The premiums paid on
policies that pay a lump sum in the event of death or disability are not
tax-deductible, but the benefits are tax-free.

Until the amendment took effect, income protection policies
were taxed differently.

If you took out an income protection policy in your name,
until this month you could deduct your premiums from your taxable income at the
end of the tax year. But you will not be able to claim this tax deduction at
the end of the 2015/16 tax year in February next year.

If you belong to a group income protection policy scheme
offered by your employer and your premiums are deducted from your salary, it is
likely that have enjoyed a tax deduction. The withdrawal of this tax deduction
will, from this month, result in an increase in your Pay As You Earn (PAYE) tax
and a decrease in your take-home pay.

Employee benefits company NBC Holdings says an employee who
pays a premium of R50 a month and who is on a marginal tax rate of 18 per cent
will see a reduction of R9 in his or her take-home pay.

Remember that the change to the marginal rates of tax, which
were announced in the Budget, could also result in an increase in the tax you
pay and a decrease in your monthly take-home pay at the end of March.

The change to the tax rates and to how income protection
policies are taxed will not affect you if you earn below the tax threshold,
which, for the 2015/16 tax year, is R73 650 a year for taxpayers under the age
of 65.

If you are unable to work and have successfully claimed on
an income protection policy, your income may increase, because the benefit will
no longer be taxed. However, there will be no change if your income is below
the tax threshold or if your life assurer limits the amount paid out to you to
75 per cent of your after-tax income.

If your benefit will increase as a result of the switch to
tax-free benefits, the extent of the increase will depend on your marginal tax
rate: the more you earn and the higher your tax rate, the more you will get
out, Rowan Burger, the executive for the large corporate segment at Momentum,
says.

Using the 2014/15 tax rates, a person who earns R1 million a
year, for example, and who is on a marginal rate of 40 per cent, will see his
or her benefit payout boosted by 48 per cent. On the other hand, someone who
earns R223 625 a year and who pays tax at 25 per cent, will see his or her
payout increase by 12 per cent with the switch to tax-free benefits, Burger
says.

Most South Africans are woefully underinsured for both death
and disability, so the increase in the amount you could receive from an income
protection policy could be a welcome boost to your finances.

Many individuals with stand-alone policies cannot afford the
premiums, or do not commit enough financially to this cover, while many
employees who belong to group income protection schemes are underinsured
because of the way in which the benefit is calculated.

Brice Salence, the head of insurance pricing and reinsurance
for group risk at Momentum Employee Benefits, says most employers that offer
group disability cover base the contributions on pensionable salary – the
salary on which your retirement fund contributions are based. If you receive
cost-to-company remuneration, your pensionable salary is typically 80 per cent
of your cost-to-company salary.

Therefore, your disability benefit is typically calculated
as 75 per cent of your pensionable salary, or 75 per cent of 80 per cent of
your cost-to-company salary. Salence says the result is that most employees end
up with a disability benefit that is 60 per cent of their cost-to-company
salary, or an income replacement ratio of 60 per cent. This is generally
insufficient to meet the financial needs of a disabled claimant, she says.

Many people, particularly higher-income earners, should
therefore benefit from the change in the tax status of any benefits paid from
income protection policies, because the potential disability benefit will be
more closely aligned to their current monthly income.

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